How Can Dollar-Cost Averaging Make You a Millionaire?

You don’t have to start a company or be a real estate mogul to become a millionaire. You need to be patient and consistent over a long period of time.

The stock market can help you take advantage of the most powerful financial tool there is: Time. With time comes the magic of compound interest. Yet, a 2019 Gallup survey concluded that 45% of Americans choose not to invest in the stock market. This could be for a lot of reasons, but it means that they are missing out on some significant growth over time.

I’d like you to become a millionaire. This post is about how you can use the concept of dollar-cost averaging to get there. Dollar-cost averaging is simply choosing to divide up the total amount you want to invest into periodic purchases. So if you want to invest $12,000 into the stock market, dollar-cost averaging would mean that you would invest $1,000 per month over the course of a year.

Market Timing Doesn’t Work

We’ve all lived through ebbs and flows in the stock market. We’ve heard terms like Bull Market and Bear Market. You’ve probably asked yourself questions like, “Should I be in the stock market? If so, what stocks should I buy?” and “Is there a right time to get into the stock market?”

These are all very valid questions. You wouldn’t be alone in asking them.

I’d like to touch on the question, “Is there a right time to get into the stock market?”

You may come across different answers out there. For the sake of being brief my answer to this question is, “As soon as you can if you’re playing the right game.”

By “as soon as you can,” I mean that you have eliminated your debt and have an emergency fund of three months of your expenses.

By “if you’re playing the right game,” I mean you are investing your money in low cost index funds that track the market, not individual stocks.

If you are trying to pick individual stocks and time the market perfectly, this post isn’t for you. You’re welcome to skip it and come back for the next one.

Trust the Experts

As Peter Mallouk says in his book, The 5 Mistakes Every Investor Makes and How to Avoid Them: “Market timing doesn’t work. It just doesn’t.”

He talks about how the masses get it wrong, the media gets it wrong, economists get it wrong, investment managers get it wrong, newsletters get it wrong. You get the idea. People who try to pick stocks at exactly the right time, statistically, are not going to outperform low cost index funds over the course of time in a majority of cases.

This is the part of his book I found most interesting:

The Schwab Center for Financial Research evaluated five decisions available to an investor who has $2,000 in cash to invest once a year for 20 years (Riepe 2013):

  1. Leave the money in cash
  2. Invest all at once each time
  3. Take the cash and dollar-cost average into the market over the year buying 1/12 each month
  4. Accidentally invest all of the money at the worst possible day every year (buying on the single day the market was the highest every single year).
  5. Fortuitously invest all of the money on the best possible day each year (this person doesn’t actually exist, ever). This magical person sits on cash each year until the market is at the absolute lowest and then invests all the cash

Here’s how the numbers ended up:

  • Perfect timing: $87,004
  • Invest immediately: $81,650
  • Dollar-cost averaging: $79,510
  • Bad timing: $72,487
  • Stay in cash investments: $51,291

You can see that the mythical “perfect every single year” investor takes the lead. Again, this person doesn’t exist. However, anyone can invest a lump sum of their money immediately every single year. Turns out, this might actually be a pretty good idea if you’re investing in index funds and following the market.

Personally, I like dollar-cost averaging. In the example above, it may end up costing me $2,140 over the course of 20 years as opposed to putting all the money in immediately, but it also spreads out my risk over the course of 12 months instead of putting all my money into the market at the start of each year. It also allows me to keep some of my cash liquid (or available to me) in case a larger scale emergency (above my emergency fund) comes up.

Exactly How Dollar-Cost Averaging Can Make You a Millionaire

Let’s say, starting at age 25, you decide you’re going to max out your Roth IRA contribution every year; in 2021, the maximum you can put into a Roth IRA is $6,000 (unless you’re over 50 years old). You pick the 15th of every month to make a $500 automatic contribution from your bank account, which will get you to the $6,000 limit by the end of the year. Then, slow and steady, you continue to do this each year.

Assuming a 9% rate of growth, your money will grow to be over a million dollars by the age of 57!

We all know the rich get richer and compound interest is incredible. If you continue contributing to the Roth IRA from there, your money will be over two million dollars by the age of 64! Just in time to retire a multi-millionaire.

Start Early and Be Consistent

I’ll say it again. You don’t have to start a company or be a real estate mogul to become a millionaire. You need to be patient and consistent over a long period of time. The earlier you start the better. Ask yourself, “What can I commit to investing each month without forcing myself to spend more than I make?” Early in your life, you should strongly consider putting this money into the market to grow for you.

Taxes and Other Options

The other piece I should mention is tax savings. If you do choose to use an investing tool like the Roth IRA in the example above, you can save thousands or even tens of thousands in taxes. With a Roth IRA, you pay taxes on the money when you earn the money, and then you do not pay taxes on any growth when you take the money out. You never have to pay any taxes on that money again. It’s a long-term investing tool that I’d recommend utilizing.

The above is just one example. You could be putting your money into a 401k, or you could be taking advantage of a matching program from your employer. There are a variety of ways to invest. However, if you are consistent over a long enough period of time, dollar-cost averaging and compound interest will make you a millionaire. The key is to start investing early. Set up automatic investments every single month so you never miss a contribution to your future self.